Foreign investment monitor #9

Key insights from the latest NSI report

The third annual report offers clear data on how the NSI regime functioned from April 2023 to March 2024. Here’s what stands out: 

1. High volume of transactions reviewed. The Investment Security Unit (ISU) was busy, screening 906 transactions, up from 865 the previous year. As businesses and investors become more adept at navigating the regime’s requirements, the number of rejected notifications fell significantly, from 42 to just 24.

2. Fewer call-in notices but a higher proportion followed a voluntary notification. While the percentage of notified deals called in for in-depth review fell slightly from 7.2 percent to 4.4 percent, a higher proportion of these had been notified voluntarily (37 percent, up from 26 percent last year). This is a timely reminder for investors that acquisitions falling outside the mandatory notification regime can (and do) give rise to national security concerns, underlining the importance of carefully assessing the merits of voluntary notification to close off a (potentially lengthy) period of uncertainty. Investors should not assume that non-notified deals will fly under the radar. The ISU’s active market monitoring led to four non-notified deals being called in for in-depth review in 2023-24, and one resulting in a final order (remedies).

3. Fewer final orders. The number of final orders (remedies) fell significantly from 15 to five in 2023-24. Notably, none of these involved investors with links to China, contrasting with eight out of 15 in the previous year. However, as the new government’s most recent final order shows, this does not indicate a softening of approach towards Chinese investment but instead suggests that Chinese investors are steering clear of sensitive sectors or withdrawing from deals where remedies – and unwelcome publicity – appear likely. In 2023-24, there were 10 cases where parties withdrew from an acquisition after it had been called in for detailed review, eight of which involved Chinese investors.

4. Diverse sector focus. Defense and military, as well as dual-use sectors continue to attract the most scrutiny, but communications, advanced materials and academic research are not far behind. Defense sector deals accounted for most final orders (four), followed by military and dual-use (two) and communications (two). However, deals in a wide range of sectors are reviewed: in 2023-24, call-in notices were issued across 16 of the 17 sectors subject to mandatory notification.

5. A nationality-agnostic approach. The regime remains focused on national security regardless of the nationality of investors. Although Chinese investors remain a key focus (making up 41 percent of deals called in), investors from the UK (39 percent) and US (22 percent) also feature high on the list. In 2023-24, final orders were imposed on investors from the UK (two), the US (two) and one each from Canada, France and the UAE, illustrating how, in some cases, the sensitivity of the target alone can merit intervention.

Will Labour change the UK’s approach to investment screening?

After fourteen years of Conservative-led rule, the new Labour government took office in July 2024 with national security and economic growth high on the agenda.

Already, the government is actively assessing threats through a Strategic Defence Review and a separate audit of UK-China relations, which will, as per the Labour Party’s pre-election manifesto, “improve the UK’s capability to understand and respond to the challenges and opportunities China poses.” Both reviews are expected to report in the first half of 2025.

The publication of Labour’s green paper for a modern industrial strategy in October 2024 further underscores the government’s approach towards critical industries and supply chains. It makes one thing clear: promoting investment and building economic resilience in priority growth sectors are intrinsically linked. In fact, five of the eight sectors identified for investment and growth – advanced manufacturing, clean energy, defense, digital technologies, and life sciences – are also core areas of focus for the NSI regime. However, what this means in practice for NSI reviews remains to be seen.

The green paper highlights Labour’s commitment to:

• promoting key sectors such as emerging technologies (including AI), life sciences and clean energy to drive growth and strengthen economic security;
• reducing vulnerabilities in supply chains that could affect the UK’s access to critical inputs such as minerals, semiconductors and batteries; and
• ensuring that national security risks inform the government’s growth agenda.

The strong connections between removing barriers to investment and growth, building resilience and protecting national security highlight the ongoing alignment of policy priorities. However, as the industrial strategy begins to play out, further clarification will be needed. The government has confirmed that the NSI regime underpins its approach to attracting investment in growth sectors. But as we look ahead, we could see the regime evolve in ways that further enhance the government’s growth objectives with more targeted and proactive interventions to protect and strengthen core capabilities while also working to establish more secure supply chains for critical inputs.

In the meantime, the new government continues to enforce the regime, imposing remedies that appear broadly consistent with the previous administration. Since July 5, 2024i, the new NSI decision maker, the Rt Hon Pat McFadden MP, has already imposed five final orders – one in each of the defense and semiconductor sectors and three in energy – aimed at safeguarding strategic assets and capabilities, while restricting the sharing of sensitive information. The new government’s first (and only so far) prohibition concerns Chinese investment in the UK’s semiconductor industry, indicating a consistent approach towards protecting UK-developed technology to that taken by the previous government.

The first court judgment on the regime underlines the high bar for parties trying to challenge remedy decisions. In LetterOne’s judicial review of the government’s order requiring it to divest its entire shareholding in fibre broadband company Upp rather than impose less intrusive measures, the court confers consideration discretion on the government: “the court will treat as axiomatic that Parliament has entrusted the assessment of risk to national security to the executive and not to the judiciary.” The judgment of November 20, 2024 confirms that the regime allows the Secretary of State to take measures that he or she reasonably considers will prevent, remedy or mitigate the risk to national security and “that question involves matters of judgment and policy which the court is not equipped to decide.”

What should investors expect next?

Several potential developments, which we highlighted in our previous edition of FI Monitor, are worth watching.

The government is due to review and report on the mandatory sectors by January 2025. This long-awaited consultation could lead to important updates in areas such as advanced technologies and materials, which require adjustments to address technological advancements and new risks from supply chain dependencies. Additionally, there is potential for critical infrastructure sectors to be expanded, with proposals from the previous government suggesting that water be included alongside other regulated industries.

Other reforms proposed by the previous government include the implementation of technical exemptions for the appointment of liquidators. However, the jury is still out on whether the current government will introduce more reforms to streamline the process, including exemptions for internal reorganizations or fast-tracks for UK-based or established investors from “friendly nations.” As the government looks to promote investment in strategic sectors, the case for exemptions and fast-tracks is growing but at a time of heightened geopolitical tensions the evidence will need to show that the benefits of reforms for investors outweigh any risks for the UK. 

The early actions of the Labour government indicate that its approach towards national security investment screening is not softening but may sharpen. With a modern industrial strategy and a renewed focus on promoting investment and building resilience of strategic sectors, investors are now looking for more clarity on what this means in practice for the NSI regime in the months and years ahead.

The long-awaited consultation on mandatory notification sectors could signal a refresh, which supports the government’s growth mission. The government’s targeted plans for the eight growth sectors outlined in the industrial strategy, coupled with insights from the Strategic Defence Review and the UK-China audit, will also be pivotal for shaping investor certainty and confidence. Understanding which types of deals will attract more (or less) scrutiny is essential for making informed investment decisions.

Ultimately, however, investors should not expect a loosening of the rules. The government has made it clear that its strategy for attracting international investment is firmly anchored in the NSI regime and other protective mechanisms, aimed at ensuring secure investments and cultivating a more resilient UK economy.